Don’t sleep on the G20’s ambitious roadmap for sustainable finance

• The G20 Sustainable Finance Working Group tackled taxonomies, disclosure requirements and capacity building, and outlined a packed agenda on sustainable finance through 2025
• Upcoming milestones are likely to include broad acceptance for anchoring climate reporting requirements to standards from the IFRS Foundation and the release of the ‘common ground taxonomy’ by year-end
• The scale of the challenge will be difficult for every financial institution, but those based in emerging and developing countries will face significant challenges building enough capacity in responsible finance, and can benefit by starting work sooner rather than later

After a two-year absence from the G20, the Sustainable Finance Study Group was upgraded to become the G20 Sustainable Finance Working Group (SFWG), and released its synthesis report and a detailed roadmap outlining where sustainable finance fits into the upcoming G20 agenda. The roadmap was adopted as part of the final G20 Leaders Declaration. The SFWG focused its efforts on three interlinked topics:

1. Improving comparability and interoperability of aligning investments with sustainability goals;
2. Improving sustainability disclosures; and,
3. Enhancing the role of international organizations and multilaterals on achieving the Paris Agreement and Sustainable Development Goals.

The next steps on each of these points will be important for the transformation of finance, and particularly how smoothly it can be addressed within Islamic markets, most of which are emerging and developing countries.

In practical terms, the three items covered by the SFWG can be described as taxonomy developments, sustainability disclosure standardization and implementation support from international organizations and multilaterals to support more climate and sustainable development financing for emerging & developing countries.

For example, taxonomies have become increasingly commonly adopted in many parts of the world. The SFWG noted that more than 20 countries had adopted or were adopting taxonomies, including some that moved beyond ‘green’ or ‘sustainable’ taxonomies to adopting taxonomies for the different ‘unsustainable’ activities in the economy.

The proliferation of taxonomies has followed the European Union’s development of its taxonomy, as well as a different taxonomy in China. The two are currently working through the International Platform on Sustainable Finance (IPSF) on a ‘common ground taxonomy’ that the G20 Sustainable Finance Roadmap indicates will be released by the end of 2021.

In addition to China and the EU’s taxonomy, the common ground approach is designed to display “the commonalities between the taxonomies already existing within the IPSF membership and acknowledge ongoing initiatives by IPSF members to set out regulatory taxonomies”. These member countries include some emerging economies besides China, such as India, Indonesia, Morocco and Kenya, and the IPSF touts its coverage as including more than half of the world’s population, GDP and greenhouse gas emissions.

The taxonomies provide a sectoral approach to which economic activities are considered green or sustainable, and which are not. One approach would be for these definitions to be set purely on the best-in-class basis, recognizing sectors that are aligned with a low-carbon future and excluding those that are not. However, the technical screening criteria need to be informed as well by the economic impacts of different speeds of transition to a low-carbon economy, which will be different in each country, and have been the source of divergence between different taxonomies.

One of the factors that affects how taxonomies are used, or can be challenging to implement, is the lack of comparable sustainability data, which is the second focus of the G20 SFWG. There are widely known challenges with sustainability data being developed for a wider range of stakeholders apart from investors, lags in data, incomplete or inaccurate data, and a lack of assurance on the data that are released.

The G20’s recommendation in support of a solution to the data challenges is to support ongoing efforts to create an International Sustainability Standards Board (ISSB) alongside the IASB under the IFRS Foundation. This would provide a common baseline for sustainability disclosures globally, although adoption would be left up to national regulators.

The focus on the ISSB — which many countries announced support for at COP 26 — will be to define “a baseline global sustainability reporting standard while allowing flexibility for interoperability with national and regional requirements”. It will initially focus on climate change and define disclosure requirements based on investor-based perspectives defined by financial materiality, before broadening its scope later.

Although it may not get universal acceptance (the EU and US are both pursuing their own disclosure requirements to be overlaid on top of, or as substitutes for, the ISSB standards), it is expected to act as a center of gravity for other standards’ approaches to investor-focused sustainability disclosures.

And that brings the final point of the G20 SFWG’s program into relief. Although it is formally focused on international organizations and multilateral development banks, the final element of the SFWG’s work focuses on how to build the policy and capacity to deal with the issues that global efforts on taxonomies and disclosure regimes will leave uncovered.

For example, the work items listed under this final item include a focus on:

• Financial risk and financial stability implications of climate change, nature- and biodiversity-related risk analysis
• Alignment of risk definitions on climate and other risks to support regulators’ efforts to coordinate on measurement, management and reporting of sustainability risk exposures
• Development of better estimates of the macroeconomic impacts (including the distributional impacts) of climate risks and policies to support the transition to a low-carbon economy
• Building capacity for greening the financial system in emerging & developing countries, including for SMEs
• Supporting financing flows to emerging & developing countries, as well as policy levers to influence sustainable investment decisions.

The roadmap includes reference to all of the major pieces of financial sector policy and practical developments that will affect the development of responsible finance in the future, and it is a lot. From the perspective of Islamic markets, most of which are emerging or developing countries, the roadmap should provide some input on how they should prioritize their own development of efforts to embed responsible finance within their financial systems.

For financial institutions in these markets, the most important takeaway should be the level of momentum that has begun on taxonomies, disclosure requirements, and international architecture developed to institutionalize responsible finance in each country. The depth and complexity of all the elements of the roadmap, including some of the items such as increased digitization of sustainability data, is still a work in progress.

All these elements of responsible finance are developing at an international level and financial institutions that build their own responsible finance capacity will be at an advantage compared to those that wait for the roll-out of the regulatory requirements. Taking a ‘wait and see’ approach will become increasingly untenable. Like the curve of needed emissions reductions to meet the Paris Agreement targets, the curve outlining the speed of implementation for needed actions to implement responsible finance will get steeper and steeper the longer that financial institutions delay.

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